Eurofi articles: MREL & Fragmentation

The EU Resolution Framework– for more reliable and competitive banks

Elke König, Chair of the Single Resolution Board

In the European Union the BRRD and the SRMR provide a solid basis for successful resolution. They provide a broad range of tools and allows resolution authorities to collect the data needed to analyse a bank’s structures and operations, to identify and segregate critical functions, to remove impediments to resolution and to make the owners and creditors of an institution pay for its resolution rather than the taxpayer. Having said that, nothing is so good that it cannot be improved.

Triggered by the need to transpose TLAC, which will enter into force in 2019, into the European Resolution Framework, the European Commission has just launched a legislative proposal that will amend the BRRD and the SRMR.

While TLAC and MREL have the same purpose, there are important differences in the scope of these instruments. The Commission has therefore proposed to create a two pillar-system. Pillar 1 MREL would implement TLAC by establishing a harmonized minimum standard exclusively for GSIBs with components of mandatory subordination. Pillar 2 MREL, where no mandatory subordination is foreseen, would be determined individually for the remaining banks, similar to what is currently foreseen. For GSIBs, according to the proposal, an additional Pillar 2 MREL could be required by the resolution authorities on top of the Pillar 1 requirement. Our first experiences over the last two years show that sufficient resolution authority discretion is paramount in determining MREL effectively and we hope that the new legal framework once finalised will reflect this. MREL is a key tool to achieve resolvability of banks.

From another angle, it could pose difficulties if subordination, as foreseen under Pillar 1 MREL, would only be applicable to GSIBs. Cliff effects may arise, in particular with respect to other systemically important banks that do not qualify as GSIBs but often have similar characteristics and a similar footprint and compete in the same markets.

Resolution authorities must be in a position to define bank specific subordination requirements to ensure that instruments are bail-in-able with legal and operational certainty and with sufficient discretion and flexibility.

A workable solution to the subordination conundrum will also help to honour the no creditor worth off principle in resolution and ensure a fast and safe bail-in-procedure both in operational and legal terms. The SRB would of course welcome any workable subordination solution, provided it supports a flexible resolution strategy and ensures MREL is of adequate quality.

It must be noted that, as the BRRD and SRMR are already applicable law, when we anticipate their revision introducing additional requirements, a feasible mode of transition must be found. Whatever the final MREL targets will be, they should be attained as fast as possible, bearing in mind feasibility. We are, however, mindful of the challenges in individual cases.

However, there is no need for any specific changes to the BRRD and the SRMR with the aim of addressing persistent “legacy problems”, a term often cited against the backdrop of current concerns about non-performing loans (NPLs) in certain institutions and markets.

Here, efforts to clean up are indeed needed and any European impulse to support this by providing an infrastructure for asset management companies and the like can be helpful.

And in this context, we should recall that the concept of precautionary recapitalisation under the BRRD and the SRMR is not a tool to avoid resolution or liquidation where a bank is failing or likely to fail. It is – as the name rightly states – a valid but exceptional measure to restore confidence and remedy a serious disturbance in the economy of a Member State with the aim of preserving financial stability. It is meant to be a precautionary and temporary measure, reserved for solvent entities and shall not be used to offset losses that the entity has incurred or – and this is crucial – is likely to incur in the near future. It is subject to approval under the Union State aid framework – which serves as a safeguard against any misinterpretation.

Taken as a whole, the BRRD and the SRMR provide for a resolution framework that safeguards financial stability without using taxpayer’s money in case a bank fails.

Has fragmentation in the Banking Union reduced and what further work is needed?

While fragmentation has undoubtedly decreased from a regulatory perspective since the implementation of the Banking Union, there still remain issues to address. Most of these issues are not rooted in financial regulation but have economic reasons and there is undoubtedly a divergence between Member States in the core and periphery.

The BRRD is a significant step towards harmonised crisis management across the EU, but significant work remains to be done, for example on insolvency law harmonisation, on subordination, on ensuring there are effective deposit guarantee schemes across the Banking Union and on EDIS.

Regarding the importance of insolvency laws, it should be remembered that when taking a decision to apply resolution tools, the resolution authority needs to carry out a counterfactual insolvency (NCWO) analysis. While the BRRD provides a basic creditor hierarchy current and proposed national laws have set priorities for similar creditors sometimes differently. A common creditor hierarchy across Member States would remove an important source of discrepancies impacting NCWO, make implementation of the resolution process easier, and improve market transparency and pricing of instruments. A clear European-wide solution in this area would be most welcome, and in this context we welcome the intention of the European co-legislators to take this file forward quickly.

As regards national discretion within the Banking Union, the SRB will work with national resolution authorities across the Banking Union to ensure that the different authorities also take a harmonised approach on the so-called Less Significant Institutions. It is important that resolution authorities are able to coordinate effectively, and there is not a wide divergence of practices across the Banking Union.

Within the Banking Union, it is important to have a robust framework for determining the allocation of MREL within cross-border banking groups within the EU in a way that facilitates the resolution of these banking groups with the aim of preventing contagion in a crisis. An effective system for allocating internal MREL across different subsidiaries should reinforce financial stability within the EU, and align to the resolution strategy for the different banks. Internal TLAC sets the international standards for this area, helping to support international co-operation, and facilitating the resolution of G-SIBs.

There will always be differences across Member States. National policymaking on areas that fall within Member State prerogatives will naturally reflect the different preferences of national electorates. But the Banking Union reduces the level of fragmentation by providing for harmonised supervision and a harmonised resolution framework. However, a harmonised insolvency framework is still lacking, and while different Member States still have different insolvency systems fragmentation will remain an issue.